March 24, 2010

As ever, none of the foregoing should be taken as financial advice – if you want that you’ll have to consult a professional – but I’ve noticed that a few people have recently found themselves in Uncharted Territory after searching for information about Lloyds shares. I hope they aren’t trying to decide what to do about the rights issue because that’s long since all been and gone. Maybe what people are looking for, though, is a conversion of the current share price to the pre-rights price.

Back in November I discussed the theoretical ex-rights price (TERP) in a number of posts. The bottom line is that prior to the rights issue Lloyds shares were trading at around 90p, but the effect of the new share issue meant that following the rights issue they would be expected to trade at around 60p.

60p would represent a “par” performance. If demand for the shares increased following the rights issue – as a result of some good news, perhaps – then they’d trade at a higher price.

The question is what price would Lloyds shares have had to be trading at for the TERP to be 64p?

This is easily calculated. We simply (1) multiply the current share price by the number of shares in circulation following the rights issue (but see Note 1 below), (2) subtract the funds (£13.5bn) raised by the rights issue (see also Note 2), then (3) divide by the number of shares before the rights issue.

Obviously Lloyds share price tomorrow might be 65p or 63p, so a general calculation is needed.

Obviously, too, we could devise a formula, but it’s also simple to put a few columns in a spreadsheet and plot a graph:

So if Lloyds’ share price were to reach 70p, this would be very roughly equivalent to 115p before the rights issue.

The whole point of this exercise, of course, is that knowledge that there was an upcoming rights issue may have depressed the Lloyds share price before the rights were even issued. The additional issue of shares would be expected to depress the share price – supply and demand – and market participants may have anticipated this and sold some of their holdings in advance.

The following graph from Yahoo! Finance shows how Lloyds’ share price was trading in the run-up to the rights issue last November:

So, based on my calculation, the Lloyds share price at 64p is very roughly still in a range equivalent to the 100p at which pre-rights shares were trading at roughly at the start of last October.

Hope that’s helpful and feel free to point out any errors or criticise my assumptions, in particular those in the two Notes below.

———–
Note 1: My calculation ignores the further share issue since the rights issue. This diluted everyone’s holdings (including that of the Treasury, from 43% to 41%). It complicates the comparison of pre-rights and post-rights share prices, but because the latest issue was not at a significant discount I’ve assumed the effect can be ignored for a very approximate calculation.

Note 2: Only £13bn of the £13.5bn was available to the bank following the rights issue, which (scandalously) cost £500m. This is a complicating factor when comparing the post-rights price with the share price before the issue was announced. Personally, I’d be inclined to regard the £500m as money down the drain. The calculation, though, assumes it was money well spent and that shareholders received £500m of value for their £500m cash.

December 7, 2009

So good: Lloyds has clearly pitched its rights price – 37p – sufficiently low for the rights issue to succeed. The rights have significant value (around 17p just now) that someone will buy them. Even if shareholders do nothing, the rights (or the shares they represent) will be sold in the market at the end of the process.

Nevertheless, I’d argue that the rights issue itself has had a significant effect on Lloyds’ share price.

I wrote a couple of weeks ago that the theoretical ex-rights price (TERP) can only be calculated based on the closing price before the shares go ex-rights. It is only at this point that the rights issue becomes close to a mathematical exercise. Nevertheless, news-flow will continue to affect the share price.

The rights price (37p) is therefore at a discount of (59.11 – 37)/59.11 = ~37.4% and nil-paid rights should trade at 22.11p.

The question I’m interested in is how much the rights issue has depressed the Lloyds share price.

It’s worth noting first that the rights price and the share price move in lockstep:

Lloyds rights price 30/11 to 4/12

Lloyds share price 30/11 to 4/12

The only thing that is keeping these prices so closely in step is the behaviour of market participants. Profit-making opportunities arise if the prices of the shares and the rights move out of alignment. It’s a simple “wisdom of crowds” effect.

The above graphs also show that the rights and shares have both traded consistently below the prices implied by the TERP.

The problem is that it is very difficult to separate the effect of the rights issue from the effect of news-flow. And we’ve had a lot of news: the Dubai saga, Bank of America repaying government funds and no end of speculation about the UK’s upcoming pre-budget report (PBR) which could all affect the Lloyds share price. On the other hand, the UK Supreme Court ruling that customers (aka the Office of Fair Trading) could not retrospectively challenge fees and news of the emergency loan to HBoS unbelievably kept secret during Lloyds’ takeover should have been in the share price, as these stories broke during the week leading up to the rights issue.

Nevertheless, only briefly on the first morning of the rights issue did the shares and rights trade above the TERP:

Lloyds share price 27/11

To determine whether the increased supply of Lloyds shares or news-flow because of the rights issue has affected the price, we could try comparing Lloyds price with that of other UK banks:

Lloyds share price vs RBoS' 27/11 to 4/12

Lloyds share price vs Barclays' 27/11 to 4/12

Lloyds, RBoS and Barclays are quite different businesses, but maybe we can tentatively conclude that the rights issue has caused Lloyds share price to fall relative to its peers.

But it could be worse than this. Some shareholders may have sold shares in other banks in order to take part in the Lloyds rights issue. They may be rebalancing their portfolios, whilst keeping the proportion of UK banks the same (i.e. selling some holdings in other banks to raise funds to participate in the rights issue at least for some of their entitlement, thereby keeping their holdings in the same proportions as previously to the total market values of the banks), or they may consider that Lloyds’ share price would be depressed by the rights issue.

More than that, some shareholders may have sold Lloyds shares in advance of the rights issue in order to participate. They may have tried to pre-empt the drop in Lloyds’ share price close to the rights issue.

A final comparison that may therefore be useful is Lloyds’ share price against the FTSE-100 index over the last 3 months:

Lloyds vs FTSE last 3 months

You could choose to attribute the >10% fall in Lloyds’ share price against the FTSE to the upcoming rights issue.

The problem we face is that it is impossible to be sure why people have sold shares. Financial columnists rationalise share price movements, but this is just opinion. The price may have fallen on a particular day because of fears over Dubai, for example, but it may have fallen because more shareholders wanted the money than the shares. Or both.

All we know is that there was an equilibrium between buyers and sellers of Lloyds’ shares (and rights) at a share price of 88.83p last Thursday (equivalent to 59.11p) and 54.28p right now.

It’s a question of judgement whether 59.11p, 54.28p or some other figure truly represents the long-run value of Lloyds’ shares.

Personally, I’d certainly argue that Lloyds’ share price is depressed by the rights issue. It follows that if I don’t participate in the rights issue, I have to accept that depressed share price for my rights. That’s why it seems to me that the best thing to do is to subscribe to the rights issue, even if I intend to sell the shares in a few months time.

Note that if you do nothing, the rights will be sold for you in the market and you will receive the funds raised.

Little did I know what I was letting myself in for. There are rather more side-issues than I’d reckoned on. But I’ve started so I’ll finish. I feel obliged to put the record straight on one or two points.

“Second, there are a small number of Limited Voting (LV) shares – 79 million, compared to over 27bn – in fact ~27,162 million – Ordinary Shares. These LV shares also have an entitlement to rights. What I don’t know, though, is how much these LV shares are worth. If each is worth much more than an Ordinary Share, and, more to the point, if the holder of each contributes significantly more than 50p to the rights issue, then the rest of us would have to put in a bit less than 50p.”

At the time I thought perhaps the LV shareholders might contribute some of the £13.5bn being raised in the rights issue. It did not even remotely occur to me that the LV shareholders might be entitled to rights to buy Ordinary (i.e. full voting) Shares. This seems to me entirely illogical – you’d think they’d get more LV shares instead – but is in fact the case.

“Number of Limited Voting Shares in issue as at the date of this document 78,947,368 [D]

Number of Limited Voting Shares to be issued pursuant to the LVS Capitalisation Issue 1,973,683 [E]”

And this is what the Prospectus has to say about the Capitalisation Issue (the award of additional shares to existing shareholders, similar to a scrip dividend, though feel free to shout me down on this) in the Glossary:

“LVS Capitalisation Issue: the proposed issue of new Limited Voting Shares pursuant to Article 122 of the Articles”

My dedication to the task has reached its limits. At least until I get a second wind, I will not be trying to find “Article 122 of the Articles”. (Isn’t this legalese gone mad? Shouldn’t that just be “Article 122”? Or next time I tell someone my address should I say “number 47 of the numbers”?).

Anyway, if you add D + E to B and then multiply by A, you do indeed get C, to the nearest share.

I mentioned the possibility of rounding yesterday, i.e. that shareholders would not in general be entitled to a whole number of rights. I presume, since no allowance is being made for this, that such rights are being created and will be sold in the market. Perhaps shareholders will receive a small amount for the sale of part of a right they were entitled to; perhaps they won’t. I’ll let you know if I find out.

I hope that clears the typo issue up. Sorry, Lloyds, though I still think you calculated the TERP differently to how you said you would, and indeed, as I’ll explain next time, I still think you’ve taken liberties with the TERP concept. As I said before, and will elaborate, the one true TERP is that based on the closing price just before the shares go ex-rights, that is, on tomorrow’s closing price.

November 24, 2009

Not only have Lloyds apparently managed to put a typo in their rights issue announcement and seem to have based their TERP calculation on the closing price of the shares yesterday and not their average price, they also seem to have calculated the TERP on the basis of raising £13.5bn and not the £13bn I used. Since the rights issue is costing the bank £500m (see Prospectus), my logic was that £500m has to be subtracted from the amount raised.

I presume the argument for doing the calculation the way Lloyds have is that the cost of the rights issue is in the share price already. The trouble is you could only really say this if you consider it 100% certain the rights issue will go ahead. To be fair, it’s probably not far off 100% since it’s very unlikely that the shareholders’ meeting on Thursday will vote down the rights issue. And if they did, this would in itself undermine the share price…

So perhaps the basis for the TERP calculation should be the price just before the rights issue was announced. But this would presume the rights issue was a complete surprise, which it wasn’t.

Then there are other aspects of the fund-raising that materially affect the share price: the £2.5bn fee to HMT to avoid the Asset Protection Scheme which was the alternative and the issue of “CoCos” that is part of the same restructuring exercise (and the success of which has given Lloyds shares a bit of a boost today).

So I suppose, on reflection, I will go along with the way Lloyds have done the TERP calculation and their figure of a 38.6% discount, based on last night’s closing price. The implication is that my original calculation of the rights issue price gave a figure that was slightly too low.

My main point is that it should be normal for rights issues to be heavily discounted. The share price of companies raising funds via rights issues can be volatile:

Lloyds share price over last 3 months

The difficulty in pinning down the share price that should be put into the calculation leads to a certain slipperiness in the basis for calculating the TERP – maybe the T for “theoretical” is the operative word – and suggests caution should be the name of the game in setting a rights issue price. But Lloyds is being very cautious.

Afterthought (13:45): The “slipperiness” is in calculating the TERP in advance. The TERP is only a valid measure once the rights issue is 100% certain to proceed. In the case of Lloyds we can only really say what the TERP and the rights issue discount to TERP is, based on Thursday’s closing price, just before the rights are created, and after the meeting to approve the rights issue. At this point everything is certain, and, in particular, the fees for the rights issue are committed, so the full amount raised by the rights issue should be included in the calculation (as Lloyds did it). So we (Lloyds, professional commentators and myself) are all mistaken in trying to determine a TERP until the rights issue is definite. At best the figures we’ve all been discussing are just (educated) guesses.

“Basis of Rights Issue 1.34 New Shares for every 1 Existing Ordinary Share”

since if you divide the number of new shares to be issued by the number of existing shares you get 1.34399. Suspicious those 9s, aren’t they?

I now suspect that what Lloyds meant to say was 1.344 new shares for each existing share. This would result in 36,505,301,100 new shares, 200,000 odd above the 36,505,088,579 stated. This is much closer to what would be expected since there will be some rounding down of the number of rights as 1.344 times the number of existing shares will not in general be a whole number. (Perhaps Lloyds had the data on shareholdings to calculate the number of new shares exactly).

If I’m right, the cash you need to find is 1.344 * 37p = per share or 49.728p, closer to what I was expecting than 1.34 * 37p which is only 49.58p.

I first saw a calculator on Tomorrow’s World when it was so valuable it had to be guarded. The programme claimed that such devices would eventually cost less than £5. Everyone scoffed. Of course they understated their case. Today I have a calculator included in my PC at an additional cost to me of effectively nothing – if it didn’t exist I’m sure I could download some freeware.

The proceeds divided by the number of new shares to be issued is precisely 37p.

2. 1.34 is not accurate

Lloyds provide the following data:

Number of Ordinary Shares in issue as at the date of this announcement… 27,161,682,366

Number of Ordinary Shares to be issued by Lloyds Banking Group pursuant to the Rights Issue…. 36,505,088,579

The number of new shares divided by the number of existing shares is in fact 1.3439921757…

I confess myself slightly baffled, since I can’t find a more detailed statement from Lloyds.

Is there a rounding error? But to issue more shares than implied by the 1.34 entitlement per existing share would imply rounding the millions of small shareholders’ entitlements up, whereas I would expect the number to be rounded down (you can’t have part of a right).

3. What is the discount to TERP?

The 3rd November Prospectus defined the TERP as follows (p.240):

“Theoretical Ex-Rights Price or TERP:

the theoretical ex-rights price of an Existing Ordinary Share calculated by reference to the volume weighted average price on the London Stock Exchange’s main market for listed securities of an Existing Ordinary Share on 23 November 2009″ [my stress]

“The Issue Price represents a discount of 59.5 per cent. to the Closing Price of the Company’s Ordinary Shares on 23 November 2009 (being the latest practicable date prior to the publication of this announcement) and a discount of 38.6 per cent. to the theoretical ex-rights price based on this Closing Price.” [my stress]

Yahoo! gives yesterday’s closing price as 91.47p, but, as can be seen from the graph in my post yesterday, it seems “the volume weighted average price” of Lloyds shares yesterday must have been maybe 90.7p.

At 90.7p, the total value of the existing shares is (27,161,682,366 * 0.907) = £24,635,645,906.
Add in the £13bn net being raised and divide by total number of shares after the rights issue (all in millions): £37,636/(27,162+36,505) gives TERP = 59.11p.
37/59.11 = 0.626, so on this basis the discount to TERP is only 37.4%, outside the range they gave of 38-42%.

Why 37p, then?

It seems Lloyds have been very bullish on the rights issue price.

Maybe they’re right – the shares right now are trading up more than another penny at 92.73p, according to Yahoo!

But a company’s share price is an arbitrary value. What matters is how many shares you have multiplied by the share price.

It seems to me that it is in shareholders’ interest to price rights issues as low as possible. This makes it much less likely that a rights issue will fail, because the rights will have more value. This in turn will reduce the underwriting fee. As I pointed out a while back, the underwriting fee is not a trivial sum.

I can only explain a desire to price the rights at a higher price than necessary in psychological terms – macho posturing, perhaps.

I still don’t expect this to happen in the case of this rights issue by Lloyds, but the risk is that the normal effects of trading I described yesterday depress the share price and hence the rights price so much that the rights become effectively an option to buy the shares. Shorting the stock (and buying the rights) then becomes an attractive trade, since, if the rights issue fails, the new shares that would have been bought in the rights issue have to be sold in the market by the under-writers. This depresses the price further, added to the speculators’ profits. Of course, it also undermines confidence in the company itself, further depressing the share price…

The reason this won’t happen with Lloyds is I don’t believe the issue is so much underwritten as that commitments to take up rights have been obtained from the holders of the majority of the shares (possibly of a large majority). I suspect Darling’s 43% (discussed previously) is not the whole story.

I wasn’t expecting a twist in the story quite so soon! Let’s hope everything goes smoothly…

I based my calculations on a share price of 90p which gave a TERP of ~55p and a rights issue price of ~33p. I’m pleased to see the Observer agrees, though I do worry who their “analysts” are. If they’ve merely found my blog (and it’s happened before) then their support is rather circular. I noticed, though, that Joseph Dickerson at Execution has been quoted as expecting “a rights in a 30-35p range”, which gives me rather more confidence that I haven’t done something silly.

I’m therefore going to stick my neck out and predict a rights issue price of 33.13p [see Note]. How do I arrive at this? Simple: it’s 3 rights for every 2 shares which is such a simple multiple that I expect Lloyds to be unable to resist it. Remember, we have to put in around 49.7p per share we currently hold. 2*49.7 is 99.4, divided by 3 is 33.13 to two decimal places.

What will happen to Lloyds share price then, though?

We’re coming up to the interesting part of the exercise, and I’ll be watching like a hawk.

My prediction is this:
1. Lloyds will start trading at 55p [see Note] immediately the market opens on Friday morning (when the rights are created and the shares go ex-rights).
2. The rights will start to fall from their value of 21.87p (55p – 33.13p) as some rights are sold in the market by those who simply do not have the cash to take up their entitlement.
3. The shares are dragged down, as arbitrageurs (hedge funds, say) buy rights and sell shares (or short the shares), knowing that they can exercise the rights and make a profit.
4. Other market participants with money to invest in Lloyds exploit the undervalued stock, and buy both the rights and the shares, pushing the shares back up towards 55p.

In other words, I expect supply and demand to depress Lloyds shares below the TERP over the fortnight or so before the rights issue closes. How far the shares fall is the proverbial million-dollar question. I doubt very much the shares will drop as far as 33p, but the natural depression of the price during a rights issue makes it very difficult to use this method of raising capital in a crisis, as we saw last year.

[Note (18:45 24/11): Lloyds have actually priced the rights issue at 37p, implying a “TERP” of ~60.24p. This is based on the closing price yesterday, 23rd, but the shares would be expected to start trading on 27th, when they go ex-rights, at a true TERP based on the closing price the previous day, 26th.

The reasons for the difference between the actual rights price and “TERP” and my estimates for these, above, are discussed in a Note to my previous post on this topic].

Hey, here’s an idea. If Guardian Money doesn’t really know what it’s talking about, why don’t they simply list issues in the news, inviting correspondence for publication the next weekend? It’d save on journo costs. I doubt the other papers are any better – I’m picking on the Guardian because that’s the paper I take, so really, guys, this is all a vote of confidence!

Anyway, about this 50p.

Late last Thursday, I think it was, I thought I’d check the exact amount due in the rights issue per current Lloyds share held. And I found that the shares are being sold a little cheaper to the Treasury.

The reason I checked is that there are (at least) two slight complicating factors in the Prospectus.

First, I noticed that:

“Ordinary Shareholders in the United States or any other Restricted Jurisdiction will, in any event, not be able to participate in the Rights Issue.” (section 3.2, p.32).

If such shares didn’t qualify for rights (which is not what’s stated, though is not excluded by the statement), then obviously the rest of us would have to put in a bit more to raise the £13.5bn. But one would imagine the rights would end up being sold in the market, which is what p.77 of the Prospectus seems to say (Section 15: “What should I do if I live outside the UK?”). So shareholders in Restricted Jurisdictions shouldn’t be a problem.

Second, there are a small number of Limited Voting (LV) shares – 79 million, compared to over 27bn – in fact ~27,162 million – Ordinary Shares. These LV shares also have an entitlement to rights. What I don’t know, though, is how much these LV shares are worth. If each is worth much more than an Ordinary Share, and, more to the point, if the holder of each contributes significantly more than 50p to the rights issue, then the rest of us would have to put in a bit less than 50p.

On the other hand, the Prospectus clearly states that they will issue up to 90 billion Ordinary Shares. The lowest price the new shares could be issued for is 15p, and 90bn * 15p is precisely £13.5bn.

So it seems the £13.5bn is indeed being divided equally amongst the 27bn shares – 27,161,682,366 to be exact – so shareholders will have to put in 49.70p, to 2 decimal places.

Nevertheless, I thought of another way of checking the 50p figure. I realised it was possible to work out how much the Treasury is paying for new shares in the Rights Issue. Their press release on the topic notes they’ll be “investing £5.7bn net of an underwriting fee”.

According to the Prospectus (p.104), the taxpayer currently owns 43.43% of Lloyds’ Ordinary Shares (the Treasury press release gives 43%, which is disappointingly imprecise).

43.43% of the shares comes to 11.8bn – 11,796,318,652 to be as precise as we can.

£5.7bn divided by the number of shares the Treasury holds, comes to 48.32p, not 49.7p.

My first thought was that, since the proportion of shares owned by the Treasury was rounded to 43%, perhaps the £5.7bn is a rounded figure too. But even if the real figure was £5.7999999bn, that would only be 49.17p a share, significantly less than our 49.70p.

In fact, as the holder of 43.43% of the shares, the Treasury should be putting in £5.86305bn, not “£5.7bn”.

Then I paid attention to the words after the figure £5.7bn in the press release: “net of an underwriting fee” [my stress].

Yes, what appears to be happening is that the Treasury is underwriting its own share purchase!

And, sure enough, the Prospectus has this to say (p.216):

“7.2 HMT Undertaking to Subscribe

Under the HMT Undertaking to Subscribe, subject to certain terms and conditions, including that the Resolutions relating to the Rights Issue and the HMT Transactions are passed, HM Treasury has irrevocably undertaken to procure that the Solicitor for the Affairs of Her Majesty’s Treasury (as nominee for HM Treasury) (i) votes in favour of all of the Resolutions in accordance with the recommendation of the Board (except for Resolution 4, as set out in the notice of General Meeting, regarding the HMT Transaction) and (ii) takes up its rights to subscribe for all of the New Shares to which it is entitled under the Rights Issue, at or prior to 11.00 a.m. on 11 December 2009, each at the Issue Price. Conditional upon (ii) above, the approval of Resolution 4 by the Ordinary Shareholders and the receipt by the Company of the aggregate subscription proceeds payable by HM Treasury (the ‘‘HMT Subscription Proceeds’’), the Company has agreed to pay to HM Treasury (or to such other person as HM Treasury may direct) the HMT Commitment Commission, being a fee equal to: (A) the Base Fee multiplied by the aggregate number of New Shares for which it has subscribed, plus (B) the Per Share Discretionary Fee multiplied by the aggregate number of New Shares for which HM Treasury has subscribed, in consideration, amongst other things, for the undertakings given by HM Treasury in the HMT Undertaking to Subscribe. The HMT Undertaking to Subscribe contains certain representations and warranties and indemnity provisions in favour of HM Treasury which are the same as those given in favour of the Banks (and certain other indemnified persons) under the Rights Issue Underwriting Agreement.” [my stress].

Remember that £13.5bn? Well, as I had to allow for in calculating the “TERP”, only £13bn of it goes to Lloyds.

If we calculate how much the government is paying on a basis of the total rights issue being £13bn and not £13.5bn then 43.43% is £5.6459 which is much closer to £5.7bn. Not all of the £500m will be the underwriting fee. If the Treasury is putting in exactly £5.7bn (and owns exactly 43.43% of the shares), then that implies the issue will raise £13.12bn (rounded) including arrangement fees, but net of underwriting costs. The latter therefore come to around £388m. Shocking.

My understanding is that in fact this little perk is not special to this rights issue, nor to HM Treasury. Large shareholders are routinely underwriting their own subscriptions to share issues.

Now, all this really represents is an early commitment to subscribe to the issue.

Let’s just consider how much this is worth. The issue will be at a ~40% discount to the TERP, as discussed last time. As we saw, the TERP will be around 55p, and the new shares issued at ~33p.

Is there any real chance of the share price falling below 33p before the completion of the rights issue?

Not really. Cyclone Lehman has passed through the markets and all is now calm. Lloyds raised £4bn at 38p a share back in April, when the recession and its own position looked much worse than it does now.

More to the point, would I have taken the same deal as HMT to save my share of the £388m? Yes, I would.

Before Darling got his feet under the desk at Number 11, there was a principle that shareholders were protected by “pre-emption rights”, that is, existing shareholders had to be offered the same deal offered to new shareholders. Similarly, the interests of minority shareholders are supposed to be protected from the big guys. Now, an ignorant media (and Vince Cable) eggs on the government to act exclusively in the interests of “the taxpayer”. In fact, companies must be run in the interests of all shareholders. That’s why they are legal entities. In using its stakes in the banks to impose stealth taxes on the organisations, the Treasury is dangerously close to indulging in the same sort of behaviour that put Conrad Black behind bars.

Mr Darling, might I perhaps have the temerity to suggest that, rather than whinging about bankers’ bonuses, a better strategy would be to examine some of the ways in which business insiders make massive amounts of easy money at the expense of, very often, the private shareholder, among others? And underwriting rights issues isn’t even the worst offence. Start by looking at the bankruptcy process – e.g. Telewest, Cobra Beer, Jessops and Woolworths and list the winners and losers…

There is a massive conflict of interest if large shareholders receive underwriting fees for rights issues. I have no idea whether £388m is an objectively reasonable figure or not. But I do know two things:
1. The holders of large blocks of shares who also act as underwriters – including the Treasury in this case – have no incentive to question the underwriting fee.
2. I wasn’t offered the chance to underwrite my own share purchase – i.e. commit a few weeks early – which I would quite happily have done. I’d have liked a “Commitment Commission” too, Mr Darling.

Small shareholders can work out how much the under-writing will cost them: it’s £(~388m * no. of current shares)/total number of shares i.e. ~27bn, a bit over 1.4p per share or ~£14 per 1,000 shares. Adds up, doesn’t it?

No wonder investment bankers are rolling in money when the Treasury – far from ensuring fair play – is happy to be complicit in yet another systematic mugging of Joe shareholder.

And what’s more, it’s not difficult to think of better ways of carrying out rights issues.

In recruiting Honor Blackman as a Joanna Lumley-esque figurehead, the Equitable Members Action Group has chosen well. With-profits annuitants such as Blackman, who had no choice but to stay with Equitable, have suffered more than any other category of policyholder. The others were given a choice in 2000 to get out with a 10% cut in policy values. Those that didn’t take it want compensation galore instead. Are they really that deserving of taxpayer money?” [my stress]

Maybe I’m a bear of little brain, but the Equitable Life non-GAR with-profits policy-holders have had a large chunk of their assets arbitrarily confiscated – a court put the rights of GAR holders above theirs. If this doesn’t deserve compensation, I don’t know what does. More another time.

The lesson I take from this is that you’d better look after your own finances because you can’t trust the media to look out for you when the pros screw up.

When Lloyds announced their upcoming rights issue my initial reaction was to whinge about the complexity of “deferred shares”, which I concluded are worthless, just a device to get round some stupid rule.

I also noted on that first post and subsequently that you can determine how much cash you’ll need to take up your rights. You’re going to need ~50p per share you hold going into the rights issue.

I have no idea why Lloyds didn’t spell out in the various documents they’ve issued about the rights issue that you’ll need to find ~50p per existing share to take up your entitlement to new shares. If I may be permitted to give them some feedback as a shareholder, my opinion is that it would have been a good idea to specifically include the amount of money shareholders would need to find. Perhaps those involved and the officers of any other company doing something similar in future could bear this point in mind.

In my second post on the subject I also presented the argument that a rights issue can temporarily depress a company’s share price so might be a good time to buy shares either by subscribing to the issue or otherwise. [Nothing I write on this blog should be taken as financial advice].

From the search terms that are being used to reach this blog, there are two other significant areas of confusion: the timetable and the use of the term “theoretical ex-rights price” (TERP) to determine the issue price of the new shares.

Timetable

As I understand it, for the retail investor there are only 3 key dates and the first of these appears to be another anachronism (this whole process could do with a bit of simplification):

– 20th November (Friday): the “Record Date” for entitlement to receive rights. If you’re planning to buy shares near or after this date, then, if I were you, I’d check with a financial adviser or stockbroker as to whether the deal will be in time to qualify and whether there’ll be any extra bureaucratic hassle. The Prospectus says this:

“7 If I buy Ordinary Shares after the Record Date will I be eligible to participate in the Rights Issue?
If you bought [sic] Ordinary Shares after the Record Date but prior to 8.00 a.m. on 27 November 2009 (the time when the Existing Ordinary Shares are expected to start trading ex-rights on the London Stock Exchange), you may be eligible to participate in the Rights Issue.
If you are in any doubt, please consult your stockbroker, bank or other appropriate financial adviser, or whoever arranged your share purchase, to ensure you claim your entitlement.
If you buy Ordinary Shares at or after 8.00 a.m. on 27 November 2009, you will not be eligible to participate in the Rights Issue in respect of those Ordinary Shares.”

So what’s the point of the Record Date if it’s not a real deadline?

– 27th November (Friday), 8am: rights created and can be traded or exercised. This is when I’d expect them to appear in (online) nominee accounts.

– 11th December (Friday), 11am: rights must be exercised by this time, though if you have a nominee account they’ll probably advise you of a deadline earlier than this. The new shares can be traded from start of business on the Monday (14th December).

TERP

The Lloyds Prospectus (p.6) implies that the:

“…Issue Price [will] be set at a 38 per cent. to 42 per cent. discount to TERP…”

They also define the TERP as:

“the theoretical ex-rights price of an Existing Ordinary Share calculated by reference to the volume weighted average price on the London Stock Exchange’s main market for listed securities of an Existing Ordinary Share on 23 November 2009”.

Got that?

I thought I understood how to work out the TERP, but tried to check anyway. Wikipedia’s entry is little help. It doesn’t seem to me to contain any falsehood, but then it doesn’t provide a lot of information either.

“Although the stock price is not likely to change immediately following the new rights issue, it will change as the rights expiration date approaches.”

Rubbish. No wonder we’re all confused!

The whole point is that as soon as the existing shares are split into ex-rights shares and (nil-paid) rights (at 8am on 27th November in the case of Lloyds), the (ex-rights) share price adjusts – to the TERP – to reflect the split. The rights should theoretically trade at approximately the TERP minus the subscription price for each right (i.e. how much you have to pay to exercise the right). Once all the rights are exercised, which they will be, since rights issues are underwritten, the new shares will be identical to the existing shares and should trade at the TERP, plus or minus the effect of any changes in sentiment due to events after the start of the rights issue or just because sentiment changes. I say “should” trade at the TERP, because there’s also the effect of the additional supply of shares, which may depress the share price below the TERP, as I discussed last time.

So what would we expect the TERP to be for Lloyds?

TERP Calculation

This is how I think the TERP should be calculated.

At present the shares are trading, handily, at exactly 90p. If we round down to 27 billion in circulation, Lloyds is currently worth £24.3bn.

The rights issue involves putting in more money (£13.5bn less £500m expenses) and creating more shares – we don’t know how many yet.

After the rights issue Lloyds should theoretically be worth £(24.3+13)bn = £37.3bn.

The TERP depends on how many new shares are created. For example, if the new shares are priced at 50p, there will be another 27bn. There will therefore be 54bn in circulation after the rights issue and each share would be worth £37.3/54 = ~69.1p.

In this case the rights would be expected to trade at around 19.1p.

If, in this example, the rights were trading at less than 19.1p or the shares at less than 69.1p after the start of the rights issue, then the implication is either Lloyds’ prospects have changed, or the rights issue has reduced the share price.

Lloyds say they want the rights price to be at a ~40% discount to the TERP. 50p is therefore too much (it’s more than 0.6*69.1p). You could iterate to an appropriate price but I expect they did some algebra:

No. of shares after issue = 27bn + 13.5bn/P (where P is the price of the rights issue)

So, if Lloyds shares are trading at 90p on 23rd November (the date Lloyds is using for their calculation), I’d expect the the rights to be priced at around 33p (I’ve indulged in a little rounding, so let’s not try to be too accurate now) and the TERP will be around 55p.

It’s quite possible I’ve made a horrendous error (or even more than one). If so, I’ll be happy to post a correction if someone points it out. [22:00 12/11: I’ve already corrected a small error I spotted myself!]

[Note (18:30 24/11): As discussed in a later post, Lloyds have actually gone for a rights price of 37p, implying a “TERP” of ~60.24p. The difference from my estimate is due to a number of factors:
– some rounding down on my part;
– my assumption of a 90p share price before the issue. Lloyds took the closing price of 91.47p on 23rd (even though they said they’d take the average share price that day);
– Lloyds priced the rights issue towards the bottom of the 38-42% range of discount to the “TERP” they’d announced – ~38.6% – whereas I assumed a 40% discount;
– I deducted the £500m in fees from the proceeds of the rights issue – this shouldn’t really have been done (and has a significant effect, showing how much those fees are costing shareholders), but then again, the only true TERP is that calculated on the closing price just before the rights are created.]

Now it simply isn’t true that Lloyds haven’t advised the exact sum investors will have to “cough up” (though they could have been clearer). As I pointed out last time, it’s quite simple: Lloyds wants £13.5bn, which will be divided equally amongst the ~27bn shares in circulation. That’s ~50p a share. If you own 1000 shares you’re going to be asked to put in £500. How many new shares you’ll get and at what price each is yet to be determined.

This is actually a step forward in the organisation of rights issues. The problem is that when a company announces it is going to sell a lot of shares, the price tends to fall – supply and demand – since not every share owner will be able to and want to put more cash into Lloyds equity. By delaying the announcement of the price of the new shares until the last minute, Lloyds has somewhat reduced the risk of the share price falling below the rights issue price, which would be a disaster, since, if you could just buy shares in the market for a lower price, there would be no point taking up the rights issue. The under-writers would end up with all the new shares.

What worries me most about Collinson’s comment piece and Treanor’s Q&A is that they omit part of the case for participating in the rights issue. What I’m about to say should not be construed as financial advice, but there are obvious reasons why a company’s share price might be depressed ahead of a rights issue and that in general a rights issue may be a good opportunity to invest.

The key point is supply and demand for the shares, that is, precisely what Lloyds is worrying about and the reason for the confusion about the offer price for the new shares. Many investors – funds or individuals – may simply be unable to put more money into Lloyds shares. They may just not have the cash. Or, especially if they’re a fund, they may not want Lloyds shares to rise as a proportion of their portfolio. This could even be against the rules of the fund.

Of course, some investors, such as index tracker funds, may be compelled to increase their holding in Lloyds in line with the increase in volume of its equity. But it’s difficult to think of a fund that would be compelled to take up more than its share of rights.

Therefore, it’s often argued, a rights issue is a good time to buy, because there is a surplus of sellers of the stock.

As Jill Treanor points out, you can sell some or all of your rights in the market, for example, to raise enough cash to take up the rest of your rights, a practice known as “tail-swallowing”. Such selling activity will tend to make the rights cheaper. But it’s important to understand that if the price of the rights falls, then so does the price of the existing shares. The reason is the (arbitrage) opportunity to simply sell shares and buy the rights.

Example: To simplify a little, say Lloyds shares fall to 60p when rights have been given to all the shareholders. The rights might entitle you to buy new Lloyds shares for 40p each (so you’d get 5 for every 4 shares you held at the qualifying date for the rights issue) so should sell for about 20p each (since once you’d put in the 40p you’d receive a new share exactly equivalent to the existing shares). If so many people sell their rights that the price is not 20p but drops to (say) 18p, then someone could sell shares for 60p, buy rights for 18p, subscribe to the issue for 40p and make (60 – 18 – 40)p = 2p a share. Do this for a few million shares and you’re building up a tasty bonus pot! What happens when people sell the shares to buy the rights, of course, is that the share price tends to fall until the price of the shares and the price of the rights are aligned again.

So, according to this argument, it may be a good time to buy Lloyds shares, e.g. by subscribing to the rights issue.

It might also be worth noting that Lloyds stated that it will not pay a dividend for 2 years. This may be another reason why some investors (income funds) will not want to hold the shares, though they may already have sold their holdings in the stock.

Of course, there are many reasons why it could turn out to be a bad time to buy Lloyds. They might screw up. Or we might experience the dreaded double-dip recession. And if so many people decide it’s a good time to buy Lloyds, this will push up the price and make it a bad time to buy! Though it is the largest rights issue in the UK to date…

At the end of the day, investors must make up their own minds, and, as I say, I’m not providing financial advice. Patrick Collinson (or his editors) are bold enough to allow themselves a headline “Lloyds looking unattractive” (or “Lloyds rights issue looks distinctly unattractive” in the online version). I just feel investors might also want to take into account the argument that rights issues can be a good time to invest.

Disclaimer: I worked for Lloyds in the early 1990s and own some Lloyds shares.